Thursday, July 10, 2008

Implied Odds of BCE Takeover

Recent news about the BCE takeover seems good for those who want the buyout to take place. However, Larry MacDonald gives the contrarian view explaining the difference between a Definitive Agreement and an Agreement for Purchase and Sale (the web page with this article has disappeared since the time of writing).

So, the deal is still up in the air. We might wonder what the odds are that the deal will finally take place. We can’t know this for sure, but we can look at what the market thinks the odds are.

The expected deal price is $42.75 per share in 5 months. However, BCE stock closed at only $39.09 on July 9. At a risk-free interest rate of say 5% per year, this works out to $39.89 in December. The gap between this amount and the deal price of $42.75 indicates that the market doesn’t think that this deal is a sure thing.

It’s time for some more assumptions. Let’s say that there are only two possibilities: either the deal will go ahead as planned, or the deal will die and BCE stock will drop to $30 per share in December. The current price plus 5 months of interest ($39.89) is 78% of the way from $30 to $42.75. So, the market puts the odds of completing the deal at 78%.

In reality, there are more than two possible outcomes, but this analysis gives us a sense that the market thinks that a successful outcome is likely. If you have good reason to believe that this probability is too high or too low, then you might consider trading in BCE stock for a short-term gain.

However, a gut feel and pointless overconfidence are not good reasons for having an opinion one way or the other. I have no idea whether the market is right in this case, and so I’m not going to gamble on BCE.

No comments:

Post a Comment